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Measuring and Managing

Customer Relationships

Chapter 6

Customer Metrics
 Only using financial performance metrics:
– Managers may take actions that improve short-term
financial performance
– But damage long-term customer relationships
 Both financial and nonfinancial metrics are needed to
manage performance with customers
– Must balance the pressure to meet and exceed
customer expectations
– Companies should also measure the cost-to-serve for
each customer and the profits generated

Carver – Delta Example

 Carver and Delta are customers generating about equal revenue
and seen as equally valuable customers
 A conventional cost accounting system, marketing, selling,
distribution, and administrative (MSDA) expenses were allocated
to customers at a rate of 35% of Sales
CARVER DELTA
Sales $320,000 $315,000
CGS 154,000 156,000
Gross Margin $166,000 $159,000
MSDA expenses (@35% of Sales) 112,000 110,250
Operating profit $ 54,000 $ 48,750
Profit percentage 16.9% 15.5%

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Carver – Delta Example

 Delta required a great deal of hand-holding and was
continually inquiring whether the company could
modify products to meet its specific needs
 Delta also:
– Tended to place many small orders for special
products
– Required expedited delivery
– Tended to pay slowly
 All of which increased the demands on the order
processing, invoicing, and accounts receivable process

Carver – Delta Example

 Carver, on the other hand:
– Ordered only a few products and in large quantities
– Placed its orders predictably and with long lead
times
– Required little sales and technical support
 The Accounting Manager in Marketing suspected that
Carver was a much more profitable customer than the
financial statements were currently reporting

Carver – Delta Example

 The picture of relative profitability of Carver and Delta shifted
dramatically
Carver Delta
Gross Margin (as previously) $166,000 $159,000
Marketing & tech. support 7,000 54,000
Travel to customer 1,200 7,200
Distribute sales catalog 100 100
Service customers 4,000 42,000
Handle customer orders 500 18,000
Warehouse inventory 800 8,800
Ship to customers 12,600 42,000
Total activity expenses 26,200 172,100
Operating profit $ 139,800 $ (13,100)
Profit percentage 43.7% (4.2%)

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Carver – Delta Example

 As the manager suspected, Carver was a highly
profitable customer
– Its ordering and support activities placed few demands
on the company’s marketing, selling, distribution, and
administrative resources
– Almost all the gross margin earned by selling to
Carver dropped to the operating margin bottom line

Customer Profitability
 Vilfredo Pareto, Italian economist, developed the 80–20
rule after noting that 80% of the region’s land was
owned by 20% of the population
 When companies rank products, they generally find that
the top-selling 20% of products generate 80% of the
sales
 The 80–20 rule applies well to sales revenues but it
doesn’t apply to profits

ABC Customer Analysis

 The output from an ABC customer analysis is often
portrayed as a whale curve
– A plot of cumulative profitability versus the number of customers
– Customers are ranked, on the horizontal axis from most profitable to least
profitable (or most unprofitable)

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Customer Profitability
 A whale curve for cumulative profitability typically
reveals:
– The most profitable 20% of customers generate
between 150% and 300% of total profits
– The middle 70% of customers break even
– The least profitable 10% of customers lose 50%–200%
of total profits, leaving the company with its 100% of
total profits

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Managing Customer Profitability

 High-profit customers appear in the left section of the
profitability whale curve
– These customers should be protected
– They could be vulnerable to competitive inroads
– The managers should be prepared to offer discounts,
incentives, and special services to retain the loyalty of
these valuable customers if a competitor threatens.
– The key is knowing who they are

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Managing Customers and Increasing Profitability

Options to increase customer profitability
 Process improvements

 Deploy menu-based pricing to allow customers to select

the features and services they value

 Use more discipline in granting discounts and

allowances
 Enhance the customer relationship to improve margins

and lower cost-to-serve

 Encouraging customers to use more of the company’s

products and services

 Establishing minimum order sizes for unprofitable

customers

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Activity-Based Pricing
 Pricing is the most powerful tool a company can use to
transform unprofitable customers into profitable ones
 Activity-based pricing establishes a base price for
producing and delivering a standard quantity for each
standard product
 Special services may be priced just to cover costs, or
also to earn a margin
 Activity-based pricing prices orders, not products

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Pricing Waterfall
 Before giving a customer a price increase, the
company should examine the many ways it has
already reduced the effective price the customer
actually pays
 Pricing Waterfall charts list the multiple revenue
links from the list price caused by special
allowances and discounts granted to the
customer.
 A 2% discount granted in five different ways, is a
10% discount!
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Salesperson Incentives
 Typical salesperson’s compensation plan sets minimum quotas and
provides incentive commissions based on sales revenue.
 There may be special rewards such as vacation trips for achieving
sales revenues above a stretch goal.
 These incentive plans sometimes fail to take into consideration
decreases in profitability due to special discount allowances and
arrangements negotiated to close the deal.
 Salesperson’s are motivated by volume, not by profitability of the
customer

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Life Cycle Profitability

 Companies invest considerable resources to attract new
customers, which may turn out to be unprofitable
 Customer Lifetime Value (CLV) calculates the
customer’s profit each year after all costs and the
discounted cash flows are compared to the initial
acquisition costs to obtain the total value of the customer
 A company using CLV is tracking for each customer,
how much it spent to acquire the customer and the
profits earned

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Life Cycle Profitability

 The critical parameters for calculating Lifetime
Customer Value are:
1. Initial acquisition cost
2. Profits earned per year
3. Added costs to retain the customer
4. Duration of the relationship

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Measuring Customer Performance with

Nonfinancial Metrics
 Focusing on only financial metrics may cause a company to take
actions that could risk the company’s long-term relationship with a
customer
 Most companies attempt to measure customer satisfaction by using
surveys
 Typical survey questions address:
– Product quality
– Responsiveness of company personnel
– Ease of ordering
– Customer complaint services

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Customer Loyalty
 Loyal customers are valuable for several reasons:
– Greater likelihood to repurchase
– Persuade others to become new customers
– Less likely to defect for price discounts from
competitors
– Willing to pay a price premium to retain a relationship
with a key supplier
– Willing to work with the supplier to improve
performance and develop new products

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Net Promoter Score

 Some researchers have found that there is a low
correlation between customer satisfaction and future
revenue growth
 Customers often remain with their current supplier
because of lack of inertia, high switching costs, or lack of
an alternative supplier
 A customer’s willingness to recommend a company is
strongly correlated to future sales growth
 Customer surveys have been expanded to ask if a
customer is willing to recommend the company

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